Britain's credit rating may yet survive

Thursday, February 16, 2012
By Matt Falloon and Sven Egenter, Reuters

LONDON--Britain's top-notch credit rating may survive the threat of a downgrade because economists still believe in London's resolve to erase a huge budget deficit and the central bank's ability to print money.

Rating agency Moody's imposed a negative outlook on Britain's triple-A rating late on Monday — the first such warning on London's debt since the eurozone crisis — saying the country's finances were too weak to cope with another big shock.

The stakes for Prime Minister David Cameron are high. Costly bank bailouts and runaway public spending rises under his predecessor Gordon Brown have saddled Britain with one of the developed world's highest budget deficits.

A downgrade of British debt could spook investors and make it much harder for London to raise the tens of billions of pounds of funding it needs to get through the next few years.

Economists and analysts still believe on balance, however, that Britain will get through the crisis without a downgrade. A Reuters snap poll of 10 economists taken after Moody's announcement gave only a median 27.5-percent chance that Britain would lose its triple-A standing.

Moody's issues a negative outlook if there is a one in three chance of a downgrade.

The warning, however, will hurt the Conservative-led coalition government's economic record and fuel a debate here over whether a different policy mix to bring the economy back on track would yield better results.


Britain's recovery from the steep slump in 2008-2009 has been weak. Unemployment — already at a 17-year high — is set to rise further, and Bank of England Governor Mervyn King has warned the way back to growth would be long and arduous.

But Britain is still enjoying near record-low borrowing costs. The reason is that investors still view its bonds as a relative safe haven in the global debt storm despite a deficit worse than that of France, which saw its AAA-rating downgraded by Standard & Poor's at the end of last year.

Britain, which has already had to give up on balancing the books by the time of the next election in 2015, is aiming for a budget deficit of 8.4 percent of national economic output in the 2011-12 fiscal year, falling to 7.6 percent in 2012-13, still much higher than those forecast for France or the United States.

The risks to those predictions are considerable, in particular if the economy fails to recover this year and next.

Vicky Redwood from Capital Economics predicts 10 billion pounds of extra borrowing in the 2012/2013 fiscal year on top of the government's forecast of 120 billion as she sees the economy contracting by 0.5 percent this year.

A more dramatic shock such as a euro zone break up would send Britain's debt spiraling.

Safe Haven

There are several crucial factors why Britain is seen as safer than most. The average maturity of its debt — which dictates when the government has to reimburse investors — is 14 years, much longer than many nations, according to the Britain's Debt Management Office (DMO), giving it more breathing space.

And the central bank has just embarked on another 50-billion-pound round of quantitative easing purchases. “The Bank of England is still there as the buyer of last resort and it is still buying more gilts than the DMO is issuing,” said Monument Securities strategist Marc Ostwald.

Moody's itself noted the Bank of England's key role in safeguarding investors' trust as well as the limited risk of not finding buyers for its debt.

“The UK has the lowest refinancing risk of all the large AAA economies, based on the average maturity of the UK's debt stock ... its large domestic investor base, and the willingness and ability of its central bank to undertake accommodative monetary policy,” Moody's said.

Finance minister Osborne, committed to slashing spending by about a fifth across government departments before the next election in 2015, faces the increasingly tough task of pushing through cuts while steering Britain away from a slump.

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